Monday, December 17, 2007

Subprime Problems

George Will asks some good questions on the various subprime bailout schemes:

Perhaps Washington's intervention in the subprime problem reveals the tiny tip of an enormous new entitlement: People who voluntarily run a risk, betting that they will escape unscathed, are entitled to government-organized amelioration when they lose their bets. The costs of this entitlement will include new ambiguities in the concepts of contracts and private property.

But Will's argument has a couple of soft spots:

Regarding "predatory lending," remember that Congress often operates on the principle "first criminalize, then define." But did "predatory" lenders expect the borrowers upon whom they supposedly preyed to default?

Given that lenders just discount the loans and re-sell them, I think the answer to this question is actually "yes." But the risk to the economy doesn't lie at the low end with the borrowers. The problem is that, somewhere in the byzantine packaging and leveraging of these loans, the risk associated with them got quantified wrong. The credit crunch results from lending institutions that would normally invest in relatively safe mortgage-backed securities suddenly discovering that they've got huge portfolios of what are effectively junk bonds.

STEPHANOPOULOS: The political world is now looking at the immediate gain. And Senator Clinton looks — has called for a freeze on foreclosures. Senator Edwards called for a rescue fund to be set up by the government for people who are facing these kind of foreclosures. What do you think about those ideas?

GREENSPAN: It’s important to help those people … without affecting the mortgage rates and without affecting the structure of markets. Cash [from the government] is available and we should use that in larger amounts. … It’s far less damaging to the economy to create a short term fiscal problem, which we would, than to try to fix the prices of homes or interest rates. If you do that, it’ll drag this process out indefinitely.

STEPHANOPOULOS: But by infusing cash, it sounds like you agree, then, with former Treasury secretary Larry Summers, who says that, right now, given this crisis, there has to be a bias toward activism.

GREENSPAN: It depends what you mean by activism. If you mean doing something that works, absolutely. If you mean doing something just for the sake of perceptions, that’s very costly. I don’t know if [infusing cash] would work, but it would certainly help people — it would help their incomes; it would help their personal state, without affecting the structure of the way markets are behaving and the way adjustment process is going on. It’s very critical that this thing reach a selling climax — if I may put it in other words, exhaust itself. It’s only when the markets are perceived to have exhausted themselves on the downside that they turn. Trying to prevent them from going down just merely prolongs the agony.

Update: But of course we must always be sensitive to the true human tragedy of subprime lending.